Tuesday, December 16, 2014

Disqualification of Directors: A Dichotomy in the Companies Act, 2013

[The following post is contributed by Nivedita Shankar, who is a Senior Associate at Vinod Kothari & Company. She can be contacted at nivedita@vinodkothari.com]

In case a director were to incur disqualification under section 164(2) of the Companies Act, 2013 (the “Act, 2013”), then such director shall not be eligible to be re-appointed as a director of that company or be appointed in other company for a further period of 5 years from the date on which the company commits certain failures. Thus, disqualification under section 164(2) does not envisage immediate vacation of office. Of course, disqualification is immediate but the director is allowed to serve the present tenure in that company and in other companies in which such person is a director. The intent behind this is of course to not render the company ‘board-less’. A company can possibly not function without a board and it is keeping this in mind that section 164(2) provides a carve-out to the boards of companies which have defaulted under this section. Further, one may note that a similar provision existed under section 274(1)(g) of Companies Act, 1956 (the “Act, 1956”). However, neither was that section applicable to private companies nor did it attract the provisions of section 283 of the Act, 1956 which pertained to disqualification.

The Act, 2013 has linked section 164 to section 167 leading to an impression that disqualification under section 164 leads to automatic vacation. This may seem logical if one were to be disqualified under section 164(1) i.e. become an undischarged insolvent or is declared as being of unsound mind by a Court. Most certainly such a person cannot continue as a director. However, section 164(2) is on a different footing than section 164(1).

The failure to file financial statements or inability to redeem debentures may be due to circumstances beyond the control of the company. It is under such circumstances that the board of the defaulting company will have to take steps to make good the failure. If the company was rendered board-less, then in the absence of the decision making authority, it is incomprehensible as to how will the company make good the default.

Further, one may argue that section 167(3) of Act, 2013 tackles the possibility of a board-less company by providing that the directors will be appointed by the promoters or in their absence, by the Central Government. Such a provision did not exist under Act, 1956. With increased liabilities under Act, 2013, companies are currently finding it difficult to appoint directors on the board.  Add to that the restriction on the number of directorships, which has made it difficult for companies to scout for probable directors. Clearly, in its zeal to mitigate the possibility of a ‘board-less’ company, the law-makers have not apprehended the difficulty in finding a suitable director.

One thus has to harmoniously interpret the provisions of section 164(2) and section 167 of Act, 2013. The intent of law cannot be to incorporate such a provision which will render some other provision completely otiose. If one were to conclude that sections 164(2) and 167 were to be read together, then section 164(2) will be rendered completely redundant. Thus, section 164(2) does not lead to ipso facto vacation. It envisages vacation only at the end of the present tenure which is logical also. To conclude, a plain reading of sections 164 and 167(1)(a) may give an impression that both are linked. However, given the intent behind section 164(2), it can be taken that section 167 pertains to vacation in case of disqualifications under section 164(1) only.

Does disqualification to section 164(2)(b) of Act, 2013 also apply to  directors newly appointed in the company?

It is important to note the starting lines of section 164(2)(b), which read as follows:

            “No person who is or has been a director of a company which XXX”

Thus, to attract disqualification under section 164(2)(b), it is important that the individual has to be on the board of the company when the default actually happened. However, what if the company appoints a director after incurring the default envisaged under section 164? Will the provisions of section 164(2) also apply to such a director?

In this regard, one may first refer to the provisions of Rule 3(b) of Companies (Disqualification of Directors under section 274(1)(g) of the Companies Act, 1956) Rules, 2003 which read as follows:
           
“If a company has failed to repay any deposit, irrespective of the enactment, rules or regulations under which the deposits have been accepted by the companies, or interest thereon, or redeem its debentures, or pay any dividend declared on the respective due dates, and if such failure continues for one year, as described in sub-clause (B) of clause (g) of sub-section (1) of section 274, then the directors of that company shall stand disqualified immediately on expiry of that one year from the respective due dates:

Provided that all the directors who have been directors in the relevant year, from the due date to the expiry of one year after the due date, will be disqualified:

XXX.”

Thus, under Act, 1956 it is clear that the provisions of section 274(1)(g) are applicable to only such directors who were directors – (i) during the relevant year (ii) from the due date to the expiry of one year after the due date. Any director appointed any time after these timelines will not be liable under the provisions of section 274(1)(g). The reasoning behind the same is also logical in the sense that the section acts as a deterrent to existing directors from incurring any disqualification under the section. Admittedly, a new director, during whose directorship the default did not occur, cannot be held responsible for the same and suffer the misdeeds of his predecessors. If that was to be the reading of section 274(1)(g) read with allied Rules, then the proviso to section 274(1)(g)(B) would have been rendered meaningless. The intent of the proviso is to ensure that the director who has incurred disqualification under section 274(1)(g) will be disqualified for a period of 5 years from being appointed but not beyond that. Thus, where the defaulting director is freed of disqualification after a period of 5 years, then it is not logical to conclude that a new director, who is the victim of such misdeeds, will incur any disqualification under section 274(1)(g).

Further, if one were to read the provisions of section 274(1)(g) with the allied Rules to mean that even new directors will attract the disqualification, then possibly no director will be willing to get appointed in such a defaulting company. This, however, cannot be the intent of law. The law cannot de-motivate directors from taking up new directorships. On the contrary the intent of law ought to be to deter companies from defaulting.  Even if companies end up defaulting, then adequate opportunity should be given to the company and its directors to make good the default.

Conspicuously there is no corresponding provision to Rule 3 of Rules, 2003. This will however, not change the premise of section 164(2)(b). Even if an express provision has been dropped altogether, the intent of law cannot be taken to have changed. Hence, section 164(2)(b) needs to be interpreted on similar lines as section 274(1)(g) of Act, 2013. To conclude, any director inducted after the company has defaulted as envisaged under section 164, will not be disqualified for the purpose of this section.

- Nivedita Shankar

4 comments:

Neha Shekhawat said...

the blog is great, its really helpful. I think that the section 164 and section 167 do has the connectivity because u/s 164(2) for the default relating to non payment of interest , deposits etc time of 1 year has been given to make the default good as the default is not in the control of director and u/s 164(1) for non filing of financial statements no such time limit is granted as the default is in the control of the directors. thus i think vacation of director office u/s 167 is valid. please correct me if i am wrong.

pratieksparsh said...

It may be argued that the burden of 164 (2)(a) falls more conclusively upon the Corporate Governance expectations from a director. Filing of financial statements and annual returns is after all a task that is clearly ascribed as the Board's responsibility. However, 164 (2)(b) requires a company to be in a position to repay (to be profitable) for it to make good its debts, and a grace period is thus necessary. I understand that this argument is against the Saurashtra Cement case, but still believe that it is pragmatically applicable.

Pratiek said...

It may be argued that the burden of 164 (2)(a) falls more conclusively upon the Corporate Governance expectations from a director. Filing of financial statements and annual returns is after all a task that is clearly ascribed as the Board's responsibility. However, 164 (2)(b) requires a company to be in a position to repay (to be profitable) for it to make good its debts, and a grace period is thus necessary. I understand that this argument is against the Saurashtra Cement case, but still believe that it is pragmatically applicable.

Pankita Soni said...

under section 164(2) from which date disqualification of 5years should be count if company has filed annual return and finacila staemant lastly in year 2009-10